The news will alarm ministers, with the Treasury fearful it may have to intervene to prevent another banking meltdown.

Treasury officials were last night closely monitoring the situation.

There are also growing concerns about Royal Bank of Scotland (RBS) whose shares have also fallen sharply over the past few days. RBS is involved in a major business deal involving Fortis, the Belgian bank which was partially nationalised at the weekend.

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Earlier this month, Lloyds agreed to takeover HBOS after it ran into serious financial trouble. Gordon Brown, the Prime Minister, personally helped to secure the deal by rewriting competition laws to allow it to proceed.

Under the deal, HBOS shareholders were offered 0.833 of a Lloyds' share on the day the deal was announced for each HBOS share. Therefore, Lloyds TSB has paid £12.2 billion.

However, since the deal was unveiled shares in HBOS have fallen and therefore the bank is only worth about £6.5 billion.

On Tuesday, rumours circulated among stock market traders that Lloyds would seek to renegotiate the deal. This was denied by both Lloyds and HBOS.

"The market is telling you the deal will just not go ahead in its current form," said one major investor.

Lloyds' shareholders still have to vote on the takeover and may reject it unless the terms are improved.

Gurgit Kambo, an analyst at Numis Securities, added: ``There are clearly some concerns. The uncertainty is if shareholders vote against it, then it won't go through.''

Alex Potter, a banking analyst with Collins Stewart, said: ``If I was a Lloyds shareholder, I would say no.''

However, a spokesman for HBOS, said: "We are already working on the integration planning process and it is full steam ahead as far as we are concerned. Share price volatility in bank stocks is part of the menu at the moment. These are not normal times."

However, there is a danger that HBOS shareholders would vote to reject a lower offer. Roger Lawson, a director of the UK Shareholders Association, which lobbies on behalf of retail investors, said: ``Certainly HBOS shareholders are not happy about what's being offered. They'll be even angrier if Lloyds reduces its offer. It's only half the net asset value; the directors should not sell at that price.''

Shares in RBS also fell on Tuesday - dropping by almost three per cent following a 13 per cent fall on Monday. RBS is involved in a multi-billion pound deal with Fortis to sell the assets of a Dutch bank.

RBS investors have been unnerved by Fortis's problems because it is in the process of splitting ABN Amro's Dutch operations with RBS, following their consortium takeover of ABN with Spain's Santander last year for £47bn.

RBS's share price fall has also been exacerbated by the failure of the US bail-out plan to clear Congress. RBS was expected to benefit from the scheme due to its sizeable American arm.